After-tax 401(k) to Roth IRA (Comment to Ian Berger’s article)
https://irahelp.com/slottreport/more-after-tax-plan-contributions
This question is actually in response to Ian’s article:
In example 3 of the article, what if the Jamir also had an outside IRA. Would this change the pro-rata calculation?
If I have a 401(k) with pre-tax and after-tax, and the plan rules allow for segmentation. Does the pro-rata apply to the gains on the after-tax portion rolling over to a Roth? How does holding a large IRA outside the 401(k) change this?
Permalink Submitted by Alan - IRA critic on Tue, 2021-04-20 16:27
IRAs do not affect any pro rating of a 401k distribution. Any pro rating is only affected by the 401k balance types. But with separate accounting (which the vast majority of plans offer), pro rating would only occur within the after tax sub account of the plan. The rest of the plan balance (pre tax deferrals, earnings on those deferrals, and co match contributions) does not affect taxation of a distribution requested to be made solely from the after tax account.
Many plans allow either the after tax balance and their earnings to be distributed while still employed. Often the participant can either roll the account to the Roth 401k account in the plan (an in plan Roth rollover) or roll the after tax account to outside IRAs. For example, if the balance is 20,000 and 19,000 is the after tax contributions, the participant may choose to roll the entire balance to the Roth IRA and pay tax on the 1000 of gains. This simplifies the rollover process to one IRA account. However, if the participant does not wish to be taxed on the 1000 of gains (or has higher gains), a split rollover can be requested with the after tax balance going to a Roth IRA, and the gains going to a TIRA. No tax would be due.
The above split rollover cannot be used within the plan to send the gains to the pre tax 401k account, but the plan might allow the after tax amount to be rolled into the Roth 401k while the earnings are rolled to a TIRA.
Some larger 401k plans offer immediate and automatic rollovers of after tax contributions to the Roth 401k (IRR). Since this happens immediately there are no earnings generated in the after tax account, so such IRRs are tax free.
Again, other IRA accounts have no effect on this process, but when distributions are taken from an IRA, pro rating of all IRAs occurs if the IRA has basis from non deductible contributions. This is done on Form 8606.